Accounting: What the Numbers Mean

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Accounting What the Numbers Mean

• Study Outlines and Overhead Masters
• Chapter 11

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LIQUIDITY ANALYSIS

• KEY QUESTION
•  
• IS THE FIRM LIKELY TO BE ABLE TO PAY ITS
  OBLIGATIONS WHEN THEY COME DUE?
•  
• LIQUIDITY MEASURES
•  
• WORKING CAPITAL
•  
• CURRENT RATIO
•  
• ACID-TEST RATIO
•  
• KEY ISSUE
•   
• THE INVENTORY COST FLOW ASSUMPTION USED BY THE
  FIRM (FIFO, LIFO, WEIGHTED AVERAGE, OR SPECIFIC
  IDENTIFICATION) WILL AFFECT THESE MEASURES.

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ACTIVITY MEASURES

• KEY QUESTION
•  
• HOW EFFICIENTLY ARE THE FIRM'S ASSETS BEING
  USED?
•  
• ACTIVITY MEASURES
•  
• ACCOUNTS RECEIVABLE TURNOVER (OR NUMBER
  OF DAYS SALES IN ACCOUNTS RECEIVABLE)
•  
• INVENTORY TURNOVER (OR NUMBER OF DAYS SALES IN
  INVENTORY)
•  
• PLANT AND EQUIPMENT TURNOVER
•  
• TOTAL ASSET TURNOVER
• GENERAL MODEL
•  
•  
• 
  SALES FOR PERIOD
• TURNOVER
  

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PROFITABILITY MEASURES

• KEY QUESTIONS
•  
• WHAT RATE OF RETURN HAS BEEN EARNED ON
  ASSETS OR OWNERS' EQUITY?
•  
• HOW EXPENSIVE IS THE FIRM'S COMMON STOCK RELATIVE
  TO OTHER COMPANIES, AND WHAT HAS BEEN THE
  DIVIDEND EXPERIENCE?
• PROFITABILITY MEASURES
•  
• ROI - RETURN ON INVESTMENT
•  
• ROE - RETURN ON EQUITY
•  
• PRICE / EARNINGS RATIO (EARNINGS MULTIPLE)
•  
• DIVIDEND YIELD
•  
• DIVIDEND PAYOUT RATIO
•  
• KEY IDEAS

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FINANCIAL LEVERAGE RATIOS

• KEY IDEA
•  
• FINANCIAL LEVERAGE REFERS TO THE USE OF DEBT
  (INSTEAD OF OWNERS' EQUITY) TO FINANCE THE
  ACQUISITION OF ASSETS FOR THE
  FIRM.
• THE INTEREST RATE ON DEBT IS FIXED, SO IF THE
  ROI EARNED ON THE BORROWED FUNDS IS GREATER THAN
  THE INTEREST RATE OWED, ROE WILL INCREASE. THIS
  IS REFERRED TO AS POSITIVE FINANCIAL LEVERAGE.
•  
• IF THE ROI EARNED ON BORROWED FUNDS IS LESS
  THAN THE INTEREST RATE OWED, ROE WILL DECREASE.
  THIS IS REFERRED TO AS NEGATIVE FINANCIAL
  LEVERAGE.
• KEY QUESTIONS
•  
• HOW MUCH FINANCIAL LEVERAGE IS THE FIRM USING?
•  
• HOW MUCH RISK OF FINANCIAL LOSS TO CREDITORS AND
  OWNERS IS THERE?
•  
• FINANCIAL LEVERAGE RATIOS
•  
• DEBT RATIO
•  
• DEBT / EQUITY RATIO

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OTHER ANALYTICAL TECHNIQUES

• BOOK VALUE PER SHARE OF COMMON STOCK
•  
• KEY IDEA
•  
• AN EASILY CALCULATED AMOUNT BASED ON THE BALANCE
  SHEET AMOUNT OF OWNERS' EQUITY, BUT NOT VERY
  USEFUL IN MOST CASES BECAUSE BALANCE SHEET
  AMOUNTS DO NOT REFLECT MARKET VALUES OR
  REPLACEMENT VALUES.
•  
• COMMON SIZE FINANCIAL STATEMENTS
• KEY IDEA
•  
• COMPARISONS BETWEEN FIRMS (OR BETWEEN PERIODS FOR
  THE SAME FIRM) CAN BE MORE EASILY
  UNDERSTOOD IF FINANCIAL STATEMENT
  AMOUNTS ARE EXPRESSED AS PERCENTAGES OF
  TOTAL ASSETS OR TOTAL REVENUES.
•  
• OTHER OPERATING STATISTICS
•  
• KEY IDEA
•  
• NOT ALL DECISIONS AND INFORMED JUDGMENTS ABOUT AN
  ENTITY ARE BASED ON FINANCIAL DATA. NONFINANCIAL
  STATISTICS ARE FREQUENTLY RELEVANT AND USEFUL.

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